AOL Executives See Evidence of Success in New Approach

It took much internal debate, hand-wringing and number-crunching before AOL made the bold step of flipping its business model toward advertising and away from the subscription revenue that built its business.

AOL executives said yesterday that their comeback plan, announced three months ago, is starting to show signs of success.

Numbers released this week showed that in the third quarter, AOL lost 2.5 million Internet access subscribers but held on to 2 million of them as customers of its free service. Executives said they were surprised to see an additional 1 million sign up for free e-mail or download AOL's software.

Miller said AOL has started to steal advertising market share from rival Yahoo Inc. and should keep pace with the industry in ad revenue growth in future months. But he also said it will take time for AOL to reap the full benefits of its makeover, making it likely the company will continue to post revenue declines for some time.

Although AOL is late to the game of becoming a Web portal supported by ad dollars, its large audience and array of products -- including Mapquest.com and AOL instant messenger -- have been attracting more advertisers.

This week, the company reported a 46 percent jump in ad revenue for the third quarter from the comparable period a year earlier. AOL's operating income, before depreciation and amortization, grew 21 percent, to $563 million in the third quarter.

"Every green arrow is up," said AOL Vice Chairman Ted Leonsis.

But many hurdles lie ahead. AOL faces stiff competition from Yahoo, Microsoft's MSN and other Web companies that have a head start chasing online advertising dollars.

And a significant portion of AOL's 60 million Web pages simply don't exist, as far as search engines are concerned. For so long, AOL's pages were not indexed by Web crawlers, such as those owned by Google Inc. and Yahoo, because they were in a closed network accessible to only paid subscribers. With search as a major driver of Web traffic, AOL has a long way to go to get noticed by Internet users and has been busy tagging its content for indexing by search engines.

"We're 15 percent of where we want to be" in terms of AOL's presence in search-engine results, Miller said.

He said AOL's revenue will continue to fall as dial-up subscribers leave for broadband companies. But the company also has been aggressively cutting costs, mostly through layoffs, and expects to continue to deliver profit to parent Time Warner Inc. because margins on its ad revenue are higher than its subscription business.

AOL also said it has completed most of the planned layoffs at Dulles headquarters, which the company said amounted to about 1,000 jobs.

Months before AOL's August announcement that it would offer all its content at AOL.com for free and stop marketing its Internet access service, Miller said, there was a lot of anxiety about how many paying subscribers would continue to use AOL.

"We did all those fancy models, made the switch and then you're really nail biting," he recalled. "The question was, would they still use the service and would they use the service differently? That could have been a major problem. About the right number of people said they'd switch and, if anything, they use the service a little bit more."

For a company that got its start connecting people to the Internet on dial-up service, AOL has already noticed a milestone: Most of the traffic to AOL's pages now comes from broadband Internet users, not dial-up subscribers, executives said. "Next year, we could have equal revenue from old and new business," Leonsis said. "That's a big deal."

The company's focus in the months ahead, executives said, will be to encourage former customers to come back to AOL and use popular features such as e-mail and instant messaging. AOL also plans to drive traffic to its other Web properties, such as Moviefone.com and blogging company Weblogs Inc.

Despite the many changes, AOL still has an asset that could help turn its business around: its audience of 112 million monthly visitors.

"The company's a lot humbler. We've gone through a lot and learned a lot," Leonsis said. "The thing we've had and continue to keep is massive scale, and what advertisers value is, they value reach."